Report: Securitized 1031 Exchange Programs to Raise Nearly $2 Billion in 2017

Securitized 1031 programs are on pace to raise $1.80 billion this year, according to the latest industry market report issued by Mountain Dell Consulting, a market research and analytics firm focused on the securitized 1031 exchange marketplace.

Section 1031 of the Internal Revenue Code allows investors to defer paying capital gains taxes on investment property sales by reinvesting the proceeds into a similar investment property within a specified time frame. Securitized 1031 exchange programs are structured as securities and sold through the broker-dealer community.

“Most classes of real estate are bringing record sales prices,” said Louis Rogers, founder and chief executive officer of Capital Square 1031. “That is good for sellers, but can be a double-edged sword because sellers become buyers in a Section 1031 exchange. Thus, while taxpayers are receiving record prices for their relinquished property, they are paying record prices for their replacement property. Strong, sometimes unprecedented, pricing has put a strain on replacement property cash flow, even more so for [Delaware Statutory Trust] programs that have to overcome sponsor fees and securities sales costs.”

The third quarter of 2017 ended with $1.48 billion in equity raised, which exceeds the 2016 equity raising pace by $46 million, but is less than half of the $3.65 billion fundraising peak in 2006. The industry must raise additional $315 million to meet the $1.8 billion projected fundraising goal for 2017.

In 2017, there were 27 sponsors raising equity through 102 offerings, comprised of 85 registered 506(b) offerings and 17 registered 506(c) offerings. The vast majority (93 percent) were structured as Delaware statutory trusts, while the tenant-in-common structure that dominated the mid-2000s represented less than 3 percent of the space.

Of the 102 total offerings, 73 were fully subscribed and there is currently $200.6 million in equity remaining in the 29 available programs. Mountain Dell noted that overall average yields of 1031 offerings are decreasing with first year returns averaging 5.8 percent.

Inland Private Capital Corp continued to lead fundraising with 35 percent of market share, followed by Passco Companies with 14 percent. Cantor Fitzgerald and ExchangeRight Real Estate were neck-and-neck with 8 percent of the market each, while Nelson Brothers rounded out the top-five with 6 percent.

“A demand driver that has been somewhat understated in broader market research is full cycle activity,” said Keith Lampi president and chief operating officer of Inland Private and president-elect of ADISA. “In 2017 alone Inland Private expects its full cycle activity to include the sale of more than 15 assets with an aggregate sale price in excess of $350 million, which would return approximately $150 million in equity to investors, many of which may decide to reinvest their proceeds into newly offered DST product. As the industry continues to mature, I anticipate full cycle activity becoming an even more prominent piece of total industry sales in coming years.”

Multifamily replacement properties were the most popular by a landslide with 52.6 percent of industry sales pouring into the asset class. Retail and office properties came in a distant second and third with 18.6 percent and 18.2 percent of sales, respectively. Self-storage captured 4.9 percent of the total 1031 equity, followed by industrial with 2.2 percent.

“No question, the multifamily sector remains the front runner in capturing a large concentration of industry sales,” said Lampi. “That said, I believe the market has benefited from additional products which prove investors access to a wide variety of asset types. The emergence of new sectors such as self-storage, as well as unique structures with varying levels of leverage has broadened the investor base the securitized 1031 market appeals to, which has also driven the recent uptick in demand.”

While there is increased demand for 1031 offerings, and a wider variety of asset classes and geographic locations in the space, the industry may face political challenges under the Trump administration.

“Many tax practitioners are concerned that Section 1031 could be repealed when tax writing committees search to find revenue to offset revenue lost to lower tax rates,” said Rogers. “We fear that Congress will reach into the ‘junk drawer’ and repeal Section 1031 in an effort to gain offsetting revenue. This could happen in a smoke-filled conference committee meeting and no one would be able to stop it.”

He added, “Industry lobbying has been effective in creating greater awareness of the many benefits of Section 1031, including substantial job production, forced savings, and the public goal of encouraging property trades to obtain the highest and best use for properties. However, with Republicans on a tear, there is no way to accurately predict the outcome of tax reform on Section 1031.”

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